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One Expert's Secret to Landing Huge Profits During Earnings Season

The third-quarter earnings season unofficially kicks off tomorrow, with a report from Alcoa (NYSE: AA) scheduled for before the bell.

According to FactSet, Q3 earnings for companies in the S&P 500 are expected to drop 2.1%, which would mark the sixth consecutive quarter of year-over-year declines.

This would be an improvement from the 3.5% drop in earnings in the second quarter, though. And while I have voiced my concerns about what the current earnings recession means for the broader market going forward, there's no denying that the upcoming earnings season will present plenty of opportunity for traders to make quick, outsized profits.

FactSet notes that 72% of S&P 500 companies beat Q2 earnings estimates, while 19% missed expectations. This means only 9% of companies reported results that were in line with analysts' estimates. Given the high number of surprises, both bullish and bearish, it's no wonder we see increased volatility (i.e., big stock moves) during earning season.

Yet, despite the opportunity for quick gains from post-earnings moves, many investors shy away from trading around earnings reports. Their reason is simple: It's risky.

Sure, you may see gains of 5% or even 10% in a single day if you call it right. But if you're wrong, the losses can be just as big.

If you could accurately predict whether a company will beat or miss earnings estimates before its quarterly report, though, then you could make a killing.

Over the years, I've developed a proprietary earnings algorithm that helps me do just that.

With it, I have been able to predict -- with great accuracy -- whether a company's earnings will beat or miss the consensus. From January 2012 to February 2014, I used this system to generate a total return of 424.5% trading stocks.

My System for Accurately Picking Earnings Surprises

Investors often take analyst recommendations -- whether they should buy, sell or hold -- at face value. But in the past two decades, I've learned that there are overlooked details to these reports that tell a much different story. If you know what to look for, these details can spell big opportunity.

What makes my system different is that I analyze the analysts. Rather than sift through thousands of pages of data myself, I let the analysts do the work and then examine their actions leading up to earnings season.

Specifically, I'm looking at four things:

1. Who the analysts are: Have their previous predictions been accurate?
2. Research updates: What's new?
3. Changes in the consensus estimate: How large and how frequent?
4. Timeliness of analyst changes: When are their changes being made?

My system essentially looks for patterns of bullishness or bearishness from the most accurate analysts and takes into account just how dramatic their shifts in sentiment are.

For example, if an analyst with a strong track record of good calls lowers his earnings estimate by 20% below the consensus just days ahead of a report, you can bet he's got a darn good reason. If other analysts are doing the same, even in subtle ways, they likely have information that's going to impact the earnings report. That's a warning I want to heed.

I have four main "tells" I look for when I'm analyzing the analysts, and each is critical to my earnings algorithm.

Basically, I figure out the "tells" of good analysts, compare them against a series of technical indicators and figure out which companies are likely to beat or miss earnings. And I've had great success with this algorithm.

Now, if you're familiar with me, you know I'm an options guy. I use simple call and put option trades to amplify small moves in stocks into much larger gains.

In addition to the potential outsized gains, options are a perfect tool for trading earnings because they can reduce your risk. They allow you to bet on a stock's post-earnings move for just a fraction of the price you would pay to buy or short shares.

I want to give you just a few examples from this past earnings season of how well my earnings algorithm worked.

The first is TripAdvisor (NASDAQ: TRIP). Back in mid-July, I noted that the online travel agent faced a number of fundamental and technical hurdles and had just received a major downgrade from the venerable Goldman Sachs (NYSE: GS). Even before this downgrade, though, my earnings prediction models were showing a high likelihood of a weak Q2 report when the company announced on Aug. 3.

I recommended a basic put option trade to my Profit Amplifier subscribers that cost $9 per share, or $900 per contract, which controls 100 shares. This was still much cheaper than shorting 100 shares of TRIP, which would have cost about $3,445 at the time on a 50% margin. Plus, with the put, the most we could lose on that trade was the cost of the option versus theoretically unlimited losses when shorting stocks.

As I predicted, TripAdvisor missed earnings and revenue expectations and shares plunged 8% in one day. But with the put option I recommended, we booked a 33.3% return.

Then there was CVS Health (NYSE: CVS). I noticed that analysts were jockeying to raise their price targets for the stock ahead of the company's Aug. 2 earnings report -- a clear sign that they expected an earnings beat and subsequent rally. With my earnings algorithm signaling CVS was a "buy," I recommended a call option trade that risked $550 per contact.

CVS delivered a strong earnings beat and shares shot up almost 5% in one day. We, however, were rewarded with a 27.3% gain on our call option, which had been open just one week.

Finally, there was fertilizer producer Mosaic (NYSE: MOS). Despite three consecutive quarters of earnings declines and more weakness expected on the horizon, MOS had soared 15% in two weeks, pushing shares far beyond consensus price targets and right up against major technical resistance.

Analysts were lowering their estimates ahead of the early August report, and my earnings algorithm was telling me the company was going to fall short, so I recommended a put option trade that risked just $370 per contract. Sure enough, the company missed expectations -- by a whopping 50% -- but we were actually already out of the trade by then.

The stock fell hard leading up to the report, and we closed our put trade for a 35.1% profit in just three days -- an amazing 4,270% annualized.

These are the kinds of gains you can regularly make with options during earnings season (and year-round for that matter). If you're interested in learning more about the benefits of options, my earnings algorithm or my Profit Amplifier service, watch this free presentation.

And if you want to trade alongside me this earnings season, you can sign up here. We offer a 60-day, no-risk guarantee, so if you decide it's not for you within the first two months, we'll give you a full, 100% refund.